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M&A Activity (Part 3): Further Scale and Digital Remain Priorities in 2016

In December 2015, we published two blogs about M&A activity in the IT services industry in 2015 (here are the links for Part 1 and Part 2). This blog examines M&A activity in IT services in Q1 2016 and sets our expectations for the rest of this year.

In short, 2016 started off with a bang, with two very large IT services acquisitions announced in the first quarter:

  • Leidos acquiring Lockheed Martin’s IS&GS unit for $6bn
  • NTT DATA is acquiring Dell Services for $3.1bn.

Compared with last year, the whole of 2015 saw just one multi-billion acquisition announced: that of IGATE by Capgemini for $4.5bn. We expect to see more large deal activity.

Atos and CGI Likely Bidders for Large Transactions in 2016

Among all IT services vendors, Atos and CGI are the most likely buyers: their business models are based on inorganic growth.

  • Atos has clear growth ambitions. Its net cash position (estimated by NelsonHall) is ~€200m after the Unify acquisition. The U.S. continues to be a priority, in particular Managed Services, adding to the scale brought in by Xerox ITO
  • CGI now has net debt under control (estimated at ~CDN $2.0bn) and can borrow up to CDN $1.7bn. CGI acquisition targets include around software IP, U.S. commercial and U.K. commercial.

Meanwhile, three other acquisitive vendors, Leidos, NTT DATA and Capgemini, have put a temporary hold on their M&A activities. Leidos and NTT DATA obviously will focus on finalizing and integrating their acquisitions, also on reducing their net debt (~$3.4bn and ~$6.5bn respectively). Capgemini has a lower debt (~€1.8bn) but less appetite for debt leverage than, for instance, CGI, and still needs to integrate IGATE and prove this acquisition is working. The company has denied any interest in acquiring Hexaware.

TCS, Cognizant and Infosys have the cash make large acquisitions. TCS does not have a track record in large transactions and does not need one: it still is enjoying industry-leading growth in spite of its size ($16.3bn in revenues in calendar year 2015). Cognizant has also enjoyed industry-leading growth but appears to be more large acquisition minded, even after TriZetto. For both Infosys and Wipro, inorganic growth is key to their 2020 revenue targets. Infosys’ target is $20bn (up from $9.2bn in CY 2015). Wipro’s target is $15bn (up from $7.2bn). Both have experience in small to mid-sized acquisitions. Neither has of integrating a large acquisition. 

CSC is in a different situation: acquisitions are a key component of its turnaround. Having acquired UXC to gain scale in Australia, it is now in the process of acquiring Xchanging which will bring in insurance software assets, inter alia. We expect to see more mid-sized acquisitions from CSC.

Finally, the network of companies that is Deloitte continue to make small acquisitions across the globe, many of them digital related.

So what themes will prevail in 2016? In short, all the current hot topics will remain

Gaining scale in India

Mphasis, Hexaware and Zensar are likely targets in 2016. And PLM service vendor, Geometric Ltd, whose largest client is ISV Dassault Systems, is also rumored to being up for sale. Valuation multiples in India defy gravity but firms like Hexaware and Mpashis are within reach, at ~$1bn-$1.5bn.

Mid-sized deals in U.S. Commercial

As we have noted above, the likes of Atos, CGI and CSC, also some of the Indian oriented service providers are interested in mid-sized vendors with a presence and IP in specific U.S. commercial industries, including utilities (but not energy, although there will be some fire sale opportunities) and healthcare.

BpaaS, or at least a BpaaS aspiration, is likely to be a feature of some of these deals. An early example this year is Wipro’s announcement in February it is to acquire HealthPlan Services for $460m.

Digital Capabilities and RPA IP: Small to Mid-Sized Acquisitions

Looking at smaller acquisition activity, obvious attractive targets will continue to be firms, often privately held:

  • With digital services capabilities, including in digital marketing, UX, cyber security, and SaaS implementation services. In particular, we expect to see M&A activity around cyber hot up this year
  • That have IP around RPA or cognitive intelligence.

Many of these targets have headcounts in the 50 to 200 range and are local players. Competition for these firms is high and includes the largest global IT services vendors, with Accenture having led this drive for the last four years.

The hunt even extends to very small firms. Giants such as Accenture and IBM are acquiring firms with specialisms in perhaps digital strategy or SaaS services that have fewer than 100 employees.

The market is getting further crowded; telecom service providers continue to acquire in security while the advertising sector has expanded its M&A scope from UX to SaaS services.

And what will we see in the mid-term?

IoT, IT/OT and Big Data Will Become Increasingly Important in the Mid-Term

IoT, also the integration between IT and Operational Technology (OT) will drive a lot of M&A investment in the years to come, initially around IoT platforms, with the intent to reach scale, create a vertical-specific IOT platform, or gain point capabilities e.g. device security testing, creating device-specific apps. In all likelihood, acquisitions will be small in scale; an early example is that of Radius by Luxoft.

On a large scale firms that have IP around big data will be attractive (while this was not an IT services acquisition, that of The Weather Company for $2bn by IBM was an interesting move that will prove its value in the longer term).

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